Monday, March 14, 2016

What should I do about slowing dividend growth?

In the past week, two of my holdings raised their quarterly dividends. Unfortunately, those dividend increases were pretty pathetic. I evaluated each of them, to determine what to do in this situation.

Colgate-Palmolive Company (CL), together with its subsidiaries, manufactures and sells consumer products worldwide. It operates through two segments: Oral, Personal and Home Care; and Pet Nutrition. The company announced a 2.60% increase in its quarterly dividend to 39 cents/share. This marked the 53rd consecutive annual dividend increase for this dividend king. The company has managed to increase annual dividends at a rate of 10.50%/year over the past decade.

I looked at previous dividend increases since 1977 for Colgate-Palmolive, in order to put the latest dividend increase in perspective. I noticed that in 1980, the company had a 3.70% dividend raise, after keeping distributions unchanged for over an year and a half. Throughout most of the 1980s, Colgate-Palmolive maintained a rate of slow dividend growth, particularly as it increased quarterly dividends every two years. Due to the fact that the dividend increase always occurred on the last quarter of the first year after the raise, the company still managed to boost annual dividends paid to shareholders, despite the fact that the quarterly dividend was actually hiked every two years. The slow dividend growth in the 1980s was driven by slow earnings growth at the time.


Date
Quarterly Dividends
Dividend Increase
4/21/2015
 $  0.38000
5.56%
4/17/2014
 $  0.36000
5.88%
4/19/2013
 $  0.34000
9.68%
4/20/2012
 $  0.31000
6.90%
4/21/2011
 $  0.29000
9.43%
4/22/2010
 $  0.26500
20.45%
4/22/2009
 $  0.22000
10.00%
4/22/2008
 $  0.20000
11.11%
4/20/2007
 $  0.18000
12.50%
4/20/2006
 $  0.16000
10.34%
4/22/2005
 $  0.14500
20.83%
4/23/2003
 $  0.12000
33.33%
7/24/2001
 $  0.09000
13.92%
7/22/1999
 $  0.07900
14.91%
4/23/1997
 $  0.06875
17.02%
7/21/1995
 $  0.05875
14.63%
7/19/1994
 $  0.05125
13.89%
7/20/1993
 $  0.04500
16.13%
7/21/1992
 $  0.03875
16.96%
4/19/1991
 $  0.03313
17.77%
10/19/1989
 $  0.02813
21.62%
10/20/1987
 $  0.02313
8.85%
10/21/1985
 $  0.02125
6.25%
4/19/1983
 $  0.02000
6.67%
10/20/1981
 $  0.01875
7.14%
10/21/1980
 $  0.01750
3.67%
1/19/1979
 $  0.01688
8.00%
7/19/1977
 $  0.01563
13.67%

Colgate is expected to earn $2.75/share in 2016 and $3.01/share in 2017. The company has been unable to exceed the earnings of $2.65/share from 2012. After three – four years of no earnings growth, and an increase in the dividend payout ratio, it is understandable that dividends per share cannot grow by much. The stock is overvalued at 24.90 times expected earnings,  yields 2.30% and has a dividend payout ratio of 56.70%.

General Mills, Inc (GIS). manufactures and markets branded consumer foods in the United States and internationally. The company raised its quarterly dividend by 4.50% to 46 cents/share. The stock yields 3%. This marked the 13th consecutive annual dividend increase for this dividend achiever. The company has managed to increase annual dividends at a rate of 10.50%/year over the past decade.

I looked at previous dividend increases since 1984 for General Mills, in order to put the latest dividend increase in perspective. I noticed that in 1999, the company raised quarterly dividends by a token 3.80%. After that, General Mills didn’t increase dividends for five years, until 2004. There had been small dividend hikes along the way over the past decade as well, but those were during a period where the company hiked dividends twice per year.

Date
 Quarterly Dividends
Dividend Increase
4/8/2015
 $     0.44000
7.32%
4/8/2014
 $     0.41000
7.89%
7/8/2013
 $     0.38000
15.15%
7/6/2012
 $     0.33000
8.20%
7/7/2011
 $     0.30500
8.93%
7/8/2010
 $     0.28000
14.29%
1/7/2010
 $     0.24500
4.26%
7/8/2009
 $     0.23500
9.30%
7/8/2008
 $     0.21500
7.50%
4/8/2008
 $     0.20000
2.56%
7/6/2007
 $     0.19500
5.41%
1/8/2007
 $     0.18500
5.71%
7/6/2006
 $     0.17500
2.94%
1/6/2006
 $     0.17000
3.03%
10/5/2005
 $     0.16500
6.45%
7/8/2004
 $     0.15500
12.73%
1/6/1999
 $     0.13750
3.77%
4/8/1997
 $     0.13250
6.00%
4/8/1996
 $     0.12500
6.38%
7/2/1993
 $     0.11750
11.90%
7/6/1992
 $     0.10500
13.51%
7/3/1991
 $     0.09250
15.63%
7/3/1990
 $     0.08000
16.36%
7/3/1989
 $     0.06875
17.02%
7/1/1988
 $     0.05875
17.50%
7/6/1987
 $     0.05000
25.00%
10/6/1986
 $     0.04000
10.34%
4/4/1986
 $     0.03625
3.57%
7/3/1984
 $     0.03500
9.79%

General Mills is expected to earn $2.86/share in 2016 and $3.06/share in 2017. The factor that makes this company a hold at most is the inability to grow earnings per share by much since 2011. In 2011, General Mills earned $2.70/share. This provides an explanation as to why dividend growth is slowing down. As I have mentioned before, without growth in earnings per share, future dividend growth is limited. This is because a company can only increase the dividend payout ratio so much, before hitting a natural ceiling. The stock is overvalued at 21.30 times expected earnings,  yields 3% and has a dividend payout ratio of 64.30%.

The most interesting part is that each one of these companies is selling at or close to 52 weeks highs. I am tempted to sell some of those shares, since using the most recent data points I do not see much improvement on a go forward basis. Both companies sell at more than 20 times expected earnings. I would not put new capital to them if I were just starting over as a dividend growth investor.

One of the lessons I have learned is to stay invested in the companies I own, no matter what (dividend cuts being the only major exception). I have found that too much activity is counter-productive to my investment performance. After studying historical dividend growth rates for a lot of dividend growth stocks, I have learned that one should not get scared and sell at the first time of trouble or a slowdown. This is because it is impossible to predict whether any slowdown is temporary or the beginning of the end.

This means that if I were to sell my stakes in those two companies, I will be worse off because I would have to pay high taxes on gains I have generated. I would also lose out on future dividend income. In addition, the companies I purchase with the proceeds might perform worse than the original two companies. It is also quite possible that these businesses are experiencing short-term turbulence, which could very likely be overcome in a few years. These are dominant global businesses, which have stable earnings and revenues that are somewhat recession resistant. If emerging market economies rebound, and the dollar stops appreciating as much, earnings per share would finally have a tailwind, rather than a significant headwind.

On the other hand, I have learned that I should not be putting more money to work in a company where dividend growth slows down dramatically. Dividend policies reflect the expectations for business performance in the next 12 – 24 months. If management expects business to be slow, they will set a dividend policy that reflects this lackluster outlook. In other words, a small dividend hike reflects management expectations for low earnings growth in the near future.

Full Disclosure: Long CL and GIS

Relevant Articles:

The most important metric for dividend investing
Dividend Kings for 2016
Give your investments time to compound
Five Dividend Growth Investing Lessons I Have Learned
How to value dividend stocks

21 comments:

  1. Hold don't sell. But don't reinvest dividends or add more when the near term prospects for earnings growth don't look so good. Also, I believe you have "headwind" and "tailwind" backwards in your 2nd to last paragraph.

    ReplyDelete
    Replies
    1. As I mentioned in the article, I am holding. I corrected the typo

      Delete
  2. DGI,

    This is when the going gets tough for a dividend growth investor. You can smell a slow down coming when the dividend raise is very small. On the other hand, this simply could mean that they will have one or two bad years in the future. Stocks go up and down with the flow of time. No need to sellout right now while it's over valued unless you wish to take the gains, wait for the drop, then buy back into the same company at a discount. Stay strong!

    -Dividend Reaper

    ReplyDelete
    Replies
    1. I am holding tight as I mentioned in the article. Noone can time stock prices successfully, so the best bet is to buy and hold.

      Delete
  3. It seems there is a trend toward lower dividend growth....at least with most of the stocks that I own. The economy isn't great and business revenue growth is slow or stagnant in many cases. The double whammy comes with people being desperate for income and finding few choices outside of dividend stocks, driving up prices and lowering yields. Not an ideal situation for dividend investors.

    I'm not selling, nor am I buying much. It's frustrating because I'm sitting on a lot of cash (currently about 35% of our portfolios). I had planned on having all that cash invested by the end of 2016. For now, I'm doing a lot of nothing in hopes of some better pricing at some point in the future. If the occasional reasonable price pops up, I make a buy. Sure is slow going though. Good luck to us all.

    Steve

    ReplyDelete
    Replies
    1. To be fair, dividend stocks look very reasonable relative to stocks in general valuation wise (P/E ratio). That doesn't mean of course that they are cheap. I do agree that a large portion of the quality companies I would be interested in are expensive. For the other ones, they look cheap because earnings have not fallen enough or their earnings might not be as stable.

      It is interesting you have so much cash on hand. Did you invest in anything in January-February? Have you considered selling puts?

      While you do not want to overpay for a company, you also do not want to miss out on any future growth/compounding by requiring too much precision. This is of course more of a balancing act.

      Good luck in your journey!

      DGI

      Delete
    2. DGI,
      It's the quality companies that I'm interested in, for the most part. In general, they seem rather pricey to me. I do hold a few that are a long way from being dividend stalwarts though. In January, I added a small amount of AMGN and made an initial buy on MMM. No transactions in February.

      I have not considered selling puts. I don't understand options well at all and can see myself getting in trouble very easily. Perhaps someday I'll learn enough about them to test the waters.

      My wife and I are both retired and will have little hope of making up for bad decisions, so I try to keep those to a minimum :-). Generally, I'm exercising caution. My emphasis is on buying at good valuations where I can, rather than giving priority to getting the funds invested. I agree.... balancing act indeed. It's not always easy to know the right time to buy and the right time to wait.

      Good luck to you as well!

      Steve

      Delete
  4. Gis commodity based costs should go down once they exercise their forward purchase contracts for raw materials as those costs are trending down

    ReplyDelete
  5. I tend to hold tight as well. It's much easier for me to hold and avoid the capital gain tax. The tax is a huge head wind for long term investing.
    Lower growth is okay for a few years. The economy is starting to slow down so I'd be happy with minimal dividend growth this year.

    ReplyDelete
    Replies
    1. I think you are doing the smart thing by holding tight, and avoiding all taxes, commissions and trying to find something else to buy. Studies have shown that high amounts of activity is bad for returns.

      Delete
  6. I think you will eventually be vindicated for holding on to GIS. The growing middle classes in China and India will consume their products before long.

    ReplyDelete
    Replies
    1. I think GIS and CL would do fine in the long-run. I think they will return to growth at some point in the near future. I am not reinvesting dividends or adding new money there for the time being however

      Delete
  7. Personally, I'm not overly concerned with lower dividend increases, as long as the dividend increase outpaces inflation. As mentioned, the slowdown could be temporary. In these cases, the dividend increases easily beat the rate of inflation. I guess it depends on one's expectations.

    ReplyDelete
    Replies
    1. That's a very good point - inflation has been low/nonexistent recently. A 3% dividend hike when inflation is zero is equivalent to a 7% dividend hike when inflation is 4%.

      My worst expectations are that portfolio dividends will at least maintain purchasing power. Based on the past 80+ years of history, the expectation should be that US dividends grow faster than inflation, at a rate of approximately 2% more.

      Delete
  8. I'm also not concerned for lower dividend increases, dividends are just part of total return; so if dividends are down over time, so are capital gains. My only expectations are 4% real return (after inflation). If I can get that from my portfolio, based on my current savings rate, I will be fine :)

    I also agree with you: "stay invested in the companies I own, no matter what (dividend cuts being the only major exception)." Even then, I don't sell my companies. Short term bad news can be great for long-term returns. A perfect case study is KMI. Time will tell how that turns out.

    Mark

    ReplyDelete
    Replies
    1. Hi Mark,

      A 4% real return sounds possible for the next 10 – 20 years. If you start with an yield of 2% on S&P 500, and add in 5% earnings growth, and then subtract a 3% inflation, your targets will be hit.
      I weight dividend income more, because it is more dependable and predictable in the short-run than capital gains. Therefore, it is easier to live off in retirement. For example, I am reasonably certain that GIS will pay at least 46 cents/quarter for the next 1 – 2 years --- however I have no idea whether GIS share price will go above $70 or below $30 over the same time period.
      I think that holding tight and never selling could be a good strategy. I sell after a dividend cut for capital preservation purposes; I also sell when a company I own is acquired – CB most recently for partial cash, FDO last year etc.

      Delete
  9. Long GIS. Do not own CL, but like the company. I empathize with the concerns about the GIS dividend increase. I had similar thoughts with the author, but believe this is not the time to sell. GIS has been in a transition for a few years as they are transitioning towards a healthier portfolio. I believe the small dividend increase is a combination of an economy that will grow more slowly for a while and part of a natural cycle for GIS.

    ReplyDelete
    Replies
    1. Based on my experience, selling is usually a mistake. You sell a quality asset,you get some cash, but lose on future income, you pay some taxes, and figure out what to do with that cash. Holding patiently is an important trait of successful long-term investors

      That being said, if GIS cuts dividends, i will be out the second after the make the announcement

      Delete
  10. I agree with the sentiments with what others have said, hold tight, it's hard to keep growing forever and it's better for their long term performance if growth is struggling, that they hold onto more cash to drive future growth.

    Take the dividends in cash and put it to use in other companies.

    Tristan

    ReplyDelete
  11. I think that it's essential to focus on the payout ratio and the Growth of the payout ratio. If the payout ratio keeps getting bigger and bigger each year, than the dividend growth is not healtht. On the other hand if the dividend keeps growing with the payout staying the same, I would say that you have a Winner.

    ReplyDelete

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